Citizenship-based taxation is the foundation of US tax system. Consequently, US citizens and resident aliens of the United States are taxed on their worldwide income even if they live abroad. However, Americans living abroad can exclude from their income a certain amount of foreign earnings by utilizing the foreign income exclusion. Additionally, American expats can deduct certain foreign housing expenses. What is Foreign Earned Income Exclusion? This question is quite common among US expatriates.
Foreign Earned Income Exclusion Requirements
How much is the amount of Foreign Income Exclusion amount?
American expats can exclude up to $101,300 for a tax year 2016, $100,800 for 2015, $99,200 for 2014, $97,600 for 2013, $95,100 for 2012, $92,900 for 2011 and $91,500 for a tax year 2010 on US expatriate tax returns.
What is Foreign Earned Income Exclusion and Self-Employment Tax?
To learn more about the foreign income exclusion for self-employed expats, please read our article about self-employed expats and foreign exclusion.
What is Foreign Income Exclusion for Married Filing Jointly?
Americans who file Married filing jointly can claim the same amount of exclusion for each spouse if both of them meet the tests. Each spouse must meet either the physical presence test or bona fide residence test to qualify for the foreign income exclusion.
Several requirements must be met to qualify for the Foreign Income Exclusion.
What is Foreign Earned Income?
Foreign earned income is the income that US expatriates receive for the services performed in a foreign country. It is key to remember that the income must be earned as an employee or independent contractor. Consequently, the earned income includes:
- Salaries and Wages
- Self-employment income
- Commissions
- Bonuses
- Tips
- Professional fees
Some foreign income might be considered the earned income too like business profits, royalties and rents.
What is Tax Home in Foreign Country?
American expats must be aware that their tax home must be in a foreign country during the period of bona fide residence or physical presence abroad. The foreign country includes the territory, territorial waters as well as the seabed and subsoil of submarine areas over which a foreign country has exclusive rights. Moreover, a foreign country that is outside of the United States and US possessions such as Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, the U.S. Virgin Islands, or American Samoa. The international waters do not count as a foreign territory.
Tax home is the place of taxpayer’s employment, post of duty, or main place of his/her business. US expatriates who do not have a permanent place of work might consider a tax home a place where they live. For example, an American expat has been transferred to France on a 2-year assignment. This person brought his wife and children to Paris. The children go to a local French school and his wife is actively engaged in civic organizations in Paris. This American expatriate has established his tax home in a foreign country so he will be eligible to claim the foreign earned income exclusion as long as he meets the bona fide residence test or physical presence test.
US citizen or US resident alien
To claim the exclusion, it is essential that a taxpayer is a US citizen or US resident alien (green card holder) who is a citizen or national of a foreign country that has an income tax treaty with the United States.
Physical Presence Test
What is foreign earned income exclusion test? Actually, US expatriates must meet either the physical presence test or bona fide residence test to claim the foreign income exclusion, foreign housing exclusion or foreign housing deduction. American expats must be physically present in a foreign country for 330 full days during 12 consecutive months.
It is not required that 330 days must be consecutive. For example, a US expatriate who moved to London on January 1, 2013 and visited several times. One trip was from March 1 to March 6 and another trip was from September 5-12. This US expatriate has been present in a foreign country for 330 full days in 2013 so he qualifies for physical presence test.
For purposes of physical presence test, it is not required that an American expat is present in a foreign country only for employment purposes. A taxpayer can be on vacation in Italy or make a worldwide tour within the year. In both of these scenarios an American is considered outside of the United States in a foreign country.
Per the IRS, Americans do not meet the physical presence test if they have to stay in the USA for family reasons, illness, job or any other issues and do not meet 330 day rule.
Bona Fide Residence Test
What is foreign earned income exclusion bona fide status? Definition for Bona Fide test is quite confusing for many taxpayers. There are specific requirements. First, American expats must be present in a foreign country for an uninterrupted period that should be one tax year. Moreover, the taxpayer must be a US citizen or US resident alien of a foreign country that has an income tax treaty with the USA.
Second, bona fide status is not granted automatically after living in a foreign country for one year.
Third, it is essential for American expats to establish a residency in a foreign country. Visiting Paris as a tourist or traveling from one country to another as a tourist doesn’t qualify a US taxpayer as a bona fide resident.
American expats do not qualify as bona fide residents if they made a statement to foreign authorities that they are not residents of that country.
Foreign Housing Exclusion
American who qualify for foreign earned income exclusion can also deduct some foreign housing expenses. We wrote a detailed article about it earlier.
Conclusion
American expatriates must realize that a question What is foreign earned income exclusion is not that simple. The guidance from a professional expat CPA is recommended to avoid costly mistakes. International tax experts at Artio Partners who specialize in US taxes for expats will be pleased to help you.